How to Estimate the Cost of Equity: Three Methods

Microsoft's shareholders expect a yearly return for owning its shares. No filing states what that return is. It has to be estimated.

Estimate it three standard ways and you get answers from 3.6% to 11.0% a year, for the same company on the same day. Here is how each method works, with Microsoft and Apple as examples. We also show why the answers differ so much.

A company is paid for by shareholders and lenders. The lenders' cost is easy to see, because bonds have a yield. The shareholders' cost is hidden.

For Microsoft, it is also the bigger number. Microsoft's equity is 98.9% of its capital, so its cost of capital (WACC) is almost the same as its cost of equity. We work that out in What Is WACC?. That rate then sets the discount rate in a Discounted Cash Flow. Get the cost of equity wrong and every valuation built on it is wrong too.

The Capital Asset Pricing Model (CAPM) says shareholders want the safe return plus extra pay for risk:

Cost of equity = risk-free rate + beta × equity risk premium

That gives Microsoft 5.18% + 1.11 × 4.14% = 9.8%. Apple comes out at 9.7%.

CAPM's weakness is its inputs. Beta changes with the window you measure it over. Estimates of the equity risk premium differ by method. Its strength is that it does not depend on how the company pays out its cash.

This method starts from what shareholders actually receive. If a dividend grows at a steady rate forever, the return a shareholder earns is:

Cost of equity = next year's dividend ÷ share price + dividend growth rate

Microsoft paid $3.64 a share in fiscal 2026. Its dividend grew 10.2% a year over the previous five years. At that rate, next year's dividend is $4.01. That is 0.81% of the $497.93 share price. Add the 10.2% growth and the cost of equity is 11.0%.

Apple paid $1.02 a share in fiscal 2025, after growth of 5.1% a year over five years. The same sum gives just 5.4%. That is barely above the Treasury yield, for a share that carries more risk.

The model has two problems. It assumes the growth rate lasts forever. A rate of 10.2% forever is far above how fast the whole economy can grow. It also only sees dividends.

Apple pays most of its cash to shareholders by buying back shares. In fiscal 2025, it spent $90.7bn on buybacks against $15.4bn on dividends. The dividend model misses that $90.7bn entirely, so it understates Apple's cost of equity.

The earnings yield is earnings per share divided by the share price. It is the P/E ratio turned upside down.

Microsoft earned $17.95 a share in fiscal 2026. At $497.93, its earnings yield is 3.6%. Apple earned $7.46 a share in fiscal 2025. At $335.92, its earnings yield is 2.2%.

The earnings yield is the return a shareholder would get if earnings never grew and were all paid out. That fits a company with no growth. For a growing company, it comes out far too low. Both numbers here sit below the 5.18% safe Treasury yield, which cannot be what shareholders expect for taking on more risk.

The earnings yield still has a use as a check. The gap between it and the CAPM answer shows how much growth the share price is counting on.

CAPM gives similar answers for two companies with similar risk. The dividend model swings with each company's payout habits. The earnings yield ignores growth, so it understates both.

For a growing company like Microsoft or Apple, start with CAPM. Then test how much the answer moves. In our Microsoft DCF, a one-point change in the discount rate shifts the value from $260 a share to between $225 and $306.

The dividend growth model suits a steady company that pays out most of its earnings as dividends and grows slowly. The earnings yield suits a company with no growth at all.

The cost of equity is always an estimate. Pick a method that fits the company, then show how much the answer depends on it.

This explainer is part of the YX Insights Academy. Each one takes a single idea and checks it against real data.

The same approach runs through everything else we publish:

Good places to start on the website:

DISCLAIMER: This article is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.